Crude Economics
Wildfires and Absent Wildcatters

The ferocious wildfire that has consumed the Canadian town of Fort McMurray evacuated tens of thousands of people, but it also had some farther reaching consequences after oil prices jumped in anticipation of the fire interrupting Canadian crude supplies. Prices jumped a couple of percentage points in early trading over concerns that the fire was going to cut Canada’s output by as much as one million barrels of oil per day, but fell after the smoke cleared and analysts realized the impact on supply was less than feared. The WSJ reports:

Reports of damage to production facilities have been limited, and the shutdown so far has been a precautionary measure to evacuate workers. Light rains and cooler temperatures in the Alberta region were said to help slow the fire’s advance, and it was also beginning to move away from key parts of the region. […]

The lack of damage “could allow for a fast ramp-up in production, once the fire is under control,” Goldman Sachs Group Inc. said in a research note. Still, the firm noted the situation remains uncertain.

But while Canada’s supply threat turned out to be less serious than the worst-case scenario, looking ahead on a longer-term basis there’s more reason to be concerned about global output. The FT reports:

Oil explorers found 2.8bn barrels of crude and related liquids last year, according to IHS, a consultancy. This is the lowest annual volume recorded since 1954, reflecting a slowdown in exploration activity as hard-pressed oil companies seek to conserve cash. Most of the new reserves that have been found are offshore in deep water, where oilfields take an of average seven years to bring into production, so the declining rate of exploration success points to reduced supplies from the mid-2020s.

The dwindling rate of discoveries does not mean that the world is running out of oil; in recent years most of the increase in global production has come from existing fields, not new finds, according to Wood Mackenzie, another consultancy. But if the rate of oil discoveries does not improve, it will create a shortfall in global supplies of about 4.5m barrels per day by 2035, Wood Mackenzie said.

Given the time scales most oil projects work on, there’s a built-in lag to how quickly exploration—or a lack thereof—can affect supplies. The fact that oil companies are paring down budgets in the wake of collapsing crude prices (and spending much, much less on exploration as a result) doesn’t mean the oversupplied oil market is due for a rebalancing in the next few months, but the seeds (not) being planted today are going to shape the market next decade.

This is what the oil market does—it goes through boom and bust cycles, with one leading naturally into the other. Technological advances and the surprising success of American shale have surprised everyone over the past eight years or so, and there are sure to be plenty of new surprises in the coming years. Despite gutted exploration budgets and Canadian wildfires, crude seems on track to stay somewhere in the $40 range… for now.

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